Commentary: Is Outsourcing On The Outs?

Not really, but companies are taking a closer look at whether it's worth it

The announcement sent ripples of anxiety through the tech world. On Sept. 15, J.P. Morgan Chase & Co. (JPM ) said that it was terminating a seven-year, $5 billion technology-outsourcing deal with IBM. For many, it's an article of faith that corporations will gradually hand off ever more of their technology operations to big service providers such as IBM, Accenture (ACN ), and Electronic Data Systems (EDS ). Yet here was the nation's second-largest bank taking its tech back because it was strategically too important to be left to an outsider. Is outsourcing losing its steam?

The short answer is no. Most analysts and IT services companies say the J.P. Morgan move doesn't presage a major shift in the market. Still, many businesses are taking a harder look at how they handle their IT. To ensure they're getting bang for the buck, chief information officers are exerting more control over what they outsource, dividing the contracts among vendors according to specialty and, like J.P. Morgan, even ending contracts and bringing tech operations in-house. As a result, industry watchers see fewer multibillion- dollar deals and more pressure on tech-service companies' profits. "This is a wake-up call" for the industry, says Gartner Research (IT ) analyst Susan Cournoyer. "Don't take outsourcing for granted."

The issue boils down to how much of a company's IT should be outsourced. If you're J.P. Morgan, the answer is: almost none of it. When Morgan acquired Bank One Corp. in June it inherited the Chicago lender's $1 billion worth of state-of-the art technology investments made over the past three years. Austin A. Adams, the former Bank One chief information officer who has moved over to that job at Morgan, considers technology strategic since it boosts reliability and efficiency -- crucial to improving service. "Having the majority of the work performed by employees gives us the best shot at technology being a competitive advantage," he says.

Even for companies that are still true believers in outsourcing, control has become the issue. General Motors Corp. (GM ) has radically changed how it deals with its former subsidiary, EDS, which once handled most of GM's IT needs. Ralph Szygenda, GM's CIO, has 2,000 techies who craft overall strategy, select technologies, and manage EDS's managers. And to reduce his reliance on EDS, he has handed off about a third of GM's outsourcing to other contractors.

Now Szygenda is embarking on what he calls GM's third generation of outsourcing. He's getting 13 top tech-services providers to adopt the same processes for running computers, software, and networks. So when something goes wrong with a computer, there's one way of responding -- not 13. "It's a brave new world," says Szygenda. "It takes a lot of management to make it work."

Companies don't need to have the heft of GM to exert more control over their service suppliers. Since the tech slowdown, businesses commonly reopen contracts and renegotiate terms. Most of the newer deals have incentive clauses. If service providers don't meet goals for improvements in operations, they don't get paid. As part of a February, 2004, deal to provide Sprint's (FON ) customer-management services, for example, IBM is required to meet goals for the rate at which complaints are resolved in the first phone call, the customer churn rate, and even Sprint's customer-service rankings by J.D. Power & Associates.

But if companies are demanding greater control and transparency, by and large they are sticking with outsourcing. Of the thousands of companies that have off-loaded tech operations, only 3% later took them back, according to a 2003 Gartner survey. And some who did aren't too proud to change their minds. Take Farmers Group Inc. In 2000, the Los Angeles insurer grabbed back maintenance of its mainframes. While it's still keeping that job in house, Farmers handed its insurance- management applications to Computer Sciences Corp. (CSC ) in July.

It may be years before it becomes clear how much benefit companies get from outsourcing. In the meantime, expect a lot of trial and error.

By Steve Hamm

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